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Tuesday, October 25, 2011
Add Italy to the list of EU countries experience a run on its banks
According to a column by Hans-Werner Sinn on Project Syndicate, Italy has joined Ireland, Greece, Portugal and Spain in experiencing a run on its banks.
But the bond purchases are just the tip of the iceberg. Equally important, but largely unknown, is the fact that the Banca d’Italia has resorted to the printing press to cover Italy’s gigantic balance of payments deficit. The extra money printing and lending, as measured by the so-called Target deficit, effectively means drawing a credit from the ECB.
This credit replaces the private capital imports that had hitherto financed the country’s net purchases of foreign goods, but which dried up because of the crisis, and it finances a capital flight, i.e. the purchase of foreign assets.
The ECB in turn draws the Target credit from the respective national central bank to which the money is flowing and which therefore has to accept a reduction in its scope for issuing refinancing credit.
Until July, only Greece, Ireland, Portugal, and Spain had drawn Target credit, for a combined total of €330 billion. Italy was stable and did not seem to need the printing press to solve its financial problems. No longer.
In August alone, Italy’s central bank drew €40 billion in Target credit, and it probably drew roughly another €50 billion in September, when the Bundesbank’s Target loans to the ECB system increased by €59 billion (after a €47-billion hike in August). This is the highest Target loan ever drawn from the Bundesbank in a single month, and in all likelihood it went primarily to Italy....
As Italy’s monthly current-account deficit approximates only €3-4 billion, the Target credit must have compensated primarily for capital flight. Italian investors sold their assets to the banking system, which paid with newly printed money. The investors then invested the proceeds in Germany, buying shares, bonds, and other assets. In essence, Germany and Italy traded Target claims against marketable assets....
This is not the end of the world, not even for the ECB. However, the Bundesbank has entered a new regime in which it will have to borrow extensively from the private banking sector to absorb the flight money from the crisis countries. They, in turn, will continue to compensate for capital flight by cranking up the money-printing press.